Bank Valuation PDF

Bank Valuation Basics!
Bank Valuation Basics

Jay D. Wilson, CFA, CBA
February 19, 2013
Mercer Capital Depository Institutions Group
About Mercer Capital

Overview Services
Mercer Capital is a national business Valuation Advisory & Opinions
valuation and financial advisory firm.
§  Corporate Transactions
Our clients include private and public
§  Financial Reporting
operating companies, financial institutions,
asset holding companies, high-net worth §  Employee Benefit Plans
families, and private equity/hedge funds.
§  Tax Compliance and Reporting
Mercer Capital’s technical discipline of §  Litigation Support
providing well-grounded valuation opinions
is buttressed by real world experience
Financial Advisory
gained in providing advisory services.
Likewise, the market-centered orientation of §  Corporate and Strategic Advisory
financial advisory services has as its
§  Mergers & Acquisitions
foundation a keen understanding of
valuation drivers. §  Fairness Opinions
© 2013 Mercer Capital // www.mercercapital.com! 1!

Outline for Today’s Presentation
Part One: Part Two:

Q&A
Community Banks Valuation
Overview Overview
Financial Statement Basics Guideline Public Company Method
Recent Industry Trends

Guideline Transactions Method
Discounted Future Benefits Method
Special Issues
Community Banks
Overview
§  Financial institutions include several kinds of financial entities

§  Depository Institutions - Banks, bank holding companies, saving banks,
mutual savings banks, stock-owned thrift institutions, mutual thrift
institutions, and credit unions
§  Asset managers – RIAs, hedge fund managers, PE managers, broker/

dealers, etc.
§  Insurance companies – Agencies, Underwriters, Ancillary

(Administrator/Claims Adjusters)
§  Specialty Finance and Real Estate Companies

Community Banks
Overview
§  Depository institutions have several common characteristics

§  Accept deposits from consumers and/or businesses
§  Deposits are generally insured by the federal government
§  Chartered by federal government or various states and regulated by agencies of

these government
§  Generally deploy the acquired deposits by making loans to customers, either
businesses or consumers, or making other investments that provide earnings
§  Community banks are a subset of this group
Community Banks
Overview
§  What is definition of a community bank?
§  Lots of different definitions
§  Historically, definition has been banks with less than $1 billion in assets
§  FDIC definition is a bit more broad (FDIC Community Banking Study –
December 2012)
§  Definition focuses on traditional lending and deposit gathering and limited geographic
scope
§  Based on FDIC definition, 7,658 FDIC insured community banks operating within 6,914
separate organizations
§  Other interesting notes from FDIC study

§  Multi-decade consolidation trend - 17,901 federally insured banks in 1984 to 7,357 in 2011
§  Share of industry assets held by community banks has declined. Banks with assets greater
than $10 billion control 80% of industry assets in 2011 compared to 27% in 1984

Community Banks
Overview
§  Banks vs. Operating Companies

§  Key Similarities
§  The goal is to provide a return on capital invested
§  Key Differences

§  A bank’s success or failure has a more direct link to the
balance sheet
§  In operating companies, this link is less clear as issues such
as marketing, technological innovation and market position
can be more important than financial structure
Community Banks
Financial Statement Basics
Balance Sheet Overview Assets

Liabilities and
Stockholder’s Equity
§  Assets consist primarily of cash and
equivalents (vault cash, deposits at other Securities Portfolio Demand Deposits
banks, Fed Funds sold), investment Loan Portfolio Time & Savings Deposits
securities, and loans Loan Loss Allowance Total Deposits
§  Liabilities mostly consist of deposits Earning Assets Fed Funds Purchased
Cash Long-term Debt

§  Banks do not have distinction between
current and long-term assets and liabilities Plant, Property, Total Liabilities
and Equipment
Common Stock
§  Key difference from operating company Intangible Assets
Stockholder’s Equity
§  Inherent leverage in business structure to Total Assets
Total Liabilities and
support functioning of bank loans Stockholder’s Equity

Community Banks
Total Securities Interest Income

Since a bank’s Trading Account
Fed Funds + CDs + Rev Repos
Loans
Fed Funds Sold & CD's
Gross Loans & Leases Securities
balance sheet Loan Loss Allowance
Net Loans & Leases
Estimated Tax Benefit
Interest Income (FTE)
drives its income Total Earning Assets

Interest Expense
Cash and Due From Banks Deposits
statement, let’s Bank Premises

Other Real Estate Owned
Fed Funds Purchased
Other Interest Expense
Intangible Assets Interest Expense
start with the Cash Surrender Value of Life Insurance

Other Assets
Net Interest Income (FTE)
TOTAL ASSETS Fee Income

balance sheet Deposit Account Service Charges
Other Operating Income
Total Other Income
Non-Interest Operating Expense

Salaries & Benefits
Net Occupancy
Other Operating Expenses
Non-Interest Operating Expenses
Security Transactions
Loan Loss Provision
Pre-Tax Income
Taxes
NET INCOME
Community Banks
Key Balance Sheet Items

§  Loan/Deposit or Loan/Asset Ratios – one measure of the risk of a bank. A high loan/deposit ratio
signals potentially higher liquidity risk. Low ratios signal less liquidity and credit risk, but at the
expense of lowering profitability
§  Loan Portfolio Composition – extent of diversification among multiple types of loans
§  Loan Loss Reserve - reserve to cover probable loan losses in the portfolio. The loan loss reserve
is reduced by loan losses and replenished by a charge to earnings
§  Non-Performing Assets – an asset that the bank has deemed to present greater-than-average
risk of loss
§  Capital – the “cushion” available to absorb losses that occur or expand the bank’s assets.
Banking regulations provide benchmarks for capital levels
§  Capital adequacy is key
10

Community Banks
Net Interest Income Total Revenues

§  Interest Income-Interest Expense
§  Most of banks’ revenues
(-) Non-Interest Expenses
§  Expenses not related to interest often
§  Must maintain spread between rates
occur during expansion and can be
earned and rates paid
analyzed using the efficiency ratio
(+) Non-Interest Income
(-) Loan Loss Provision
§  Complements interest income and
§  Charge to replenish loan loss reserve
helps offset expenses
§  Important for growth and (-) Income Taxes
diversification
(=) Net Income
(=)Total Revenues
11
Community Banks
Key Ratios
§  Return on Equity
§  Net Income/Equity
§  Measures how productively the bank invests its capital
§  Return on Assets

§  Net Income/Total Assets
§  Measures the productivity of the assets deployed by the bank
12

Community Banks
Risk Factors
§  Credit Risk - potential that some of a bank’s investments, in either
loans or securities, may not be repaid according to their terms
§  Interest Rate Risk - changes in net interest income or the change in
the value of net assets caused by changes in market interest rates
§  Liquidity Risk - bank’s ability to meet its obligations, such as
commitments to fund loans or deposit withdrawals, in the ordinary
course of business
§  Results from loans not being immediately marketable, such that a
highly “loaned-up” bank may not be able to pay off maturing deposits
13
Community Banks
§  Banks are highly regulated entities
§  Another key difference from most operating companies
§  Key regulatory agencies include:

§  Federal Deposit Insurance Corporation (FDIC) - guarantees safety of insured deposits with
banks, through the Deposit Insurance Fund
§  Office of the Comptroller of the Currency (OCC) - chief regulator officer for national banks
and is responsible for governing the operations of national banks; assesses financial
condition, soundness of operations, quality of management, and compliance with federal
regulations
§  Federal Reserve - central banking system of the U.S.; also regulates bank holding
companies
§  U.S. Securities and Exchange Commission (SEC) - enforcing the federal securities laws and
regulating the securities industry, the nation's stock and options exchanges, and other
electronic securities markets
14

Community Banks
Basel III Capital Regulations
§  Core equity requirements are increasing
§  Minimum 7.0% tier one common with 2.5% buffer
§  Minimum 8.5% tier one and 10.5% total capital
§  Push to reduce parent company leverage

§  Trust preferred phase-out
§  Parent companies to hold more liquidity
§  Reworking of asset risk weights creates potential issue

§  Heavier risk weighting for NPAs creates pro-cyclical capital requirements
§  Community banks are heavily invested in CRE
15
Community Banks
Recent Industry Trends
Current challenges
§  Yields under NIM compression via Fed’s zero interest rate policy
§  Loan demand weak in most regions

§  Mortgage gains are supporting fee income, but the refi wave may fade
§  Operating leverage is tough to achieve given pressure on revenues

and rising compliance expenses
§  Regulatory expectations regarding higher capital ratios (and more

common equity within the capital structure)
16

Net Interest Margin

61% of the banks had a
lower YTD NIM vs. last
YTD thru 9/11
More pressure to come

given loan pricing
competition and low
reinvestment rates for
bond cash flows, while
COF leverage is limited
Peer group consists of approximately 3,600 banks with assets

between $100 million and $5 billion
Source: Mercer Capital Presentation at AOBA Conference “Capital

Management: Alternatives & Uncertainties”
17
Efficiency Ratio
Operating leverage is 80%
directionally negative
75%
post-crisis
70%
Small banks are at a
competitive 65%
disadvantage
60%
Efficiency Ratio =
55%
Non-Int’t Expenses / Assets > $10B Assets $3-10B Assets $1-3B Assets $500M - $1B
(Net Int’t Income + 2005 2009 2012
Non-Int’t Income) Source: Bank Holding Company Performance Reports

18

Credit Costs
2.00% 50.00%
Credit-related costs
Loan Loss Provision +/- OREO Losses/Gains / PTPPPO Income

Pre-Tax, Pre-Provision, Pre-OREO Income / Avg. Assets
1.80% 45.00%
have trended down, 1.60% 40.00%
offsetting pressure on 1.40% 35.00%
PPOI 1.20% 30.00%
1.00% 25.00%
But … credit leverage 0.80% 20.00%
is limited going 0.60% 15.00%
forward 0.40% 10.00%
0.20% 5.00%
0.00% 0.00%
2004Y 2005Y 2006Y 2007Y 2008Y 2009Y 2010Y 2011Y YTD @ YTD @
9/11 9/12
Loan Loss Provision + OREO / PTPPPO Income Pre-Tax, Pre-Provision, Pre-OREO Income / Avg. Assets
Peer group consists of approximately 3,600 banks with assets between $100 million and $5 billion
19
Return on Equity
ROE has rebounded 18%!
16%!
14%!
70s & 80s saw ROE 12%!

10%!
volatility via three 8%!
recessions and 6%!

4%!
sharp rate moves 2%!
0%!
84 !85 !86 !87 !88 !89 !90 !91 !92 !93 !94 !95 !96 !97 !98 !99 !00! 01! 02! 03! 04! 05! 06! 07! 08! 09!10 !11 !12 !
-2%!
90-06 “great -4%!

-6%!
moderation” -8%!
-10%!
-12%!
Assets > $10B! Assets $1-10B!
Source: FDIC

20

Return on
Tangible Equity
YTD through September
2012, ~50% of the bank
holding companies
surveyed reported ROTE
of 0-10%, representing
the highest proportion
over the 1991 to 2012
period
Proportion with negative

ROEs fell from 41% in
2009 to 10% in 2012
Data set includes bank holding companies filing Form FR Y-9C

with less than $5 billion of assets at September 30, 2012
(approximately 1,000 holding companies)
Source: Mercer Capital Presentation at AOBA Conference “Capital 21
Three Key Elements of Valuation
Cash Flow Risk Growth
22

Valuation
Overview
§  Valuation is, by its nature, forward looking
§  Value is a function of estimates of future cash flows, risk and growth,
which may or may not necessarily coincide with historical performance
§  However, historical measures can often help predict (or confirm
other estimates of) future cash flows, risk, and growth
§  Any prediction of the future depends on the quality of the inputs
§  Appropriate adjustments to historical financial metrics can aid in
making better predictions of future earnings
§  But what is an “appropriate” adjustment?
§  Valuation is a range concept
23
Valuation
Overview
§  There’s also an interaction between the three valuation
elements
§  Short term cash flows and growth can be enhanced by taking
more risk (of the credit or interest rate variety)
§  Keep in mind that earning power is in some sense a long-term
concept, not necessarily a prediction of the next quarter’s or year’s
earnings.
§  Impact of assuming an inappropriate level of risk is usually not

immediately evident
24

Valuation
Overview
§  Community banks differ from larger banks
§  Composition of revenues – non-interest income often accounts for a smaller
proportion of total revenue
§  Composition of loan portfolio – greater dependence on particular type of lending

(often commercial real estate and construction loans)
§  Capital structures – not as leveraged. Regulatory capital requirements filled to a

greater extent by components other than common equity
§  Diversification – not as diversified, as measured by geography, customer, etc.

§  Can cut both ways. A number of largest banks very diversified by product and
geography but had major write-downs in financial crisis. Community banks may know
their customers and understand the risks they are assuming better
25
Valuation
Overview
§  Community banks can differ from publicly traded community banks
§  Capital structure – private banks are more likely to have inefficient
capital structures (excess equity over public banks and regulatory
requirements)
§  Returns – more likely to see poor returns persist for longer periods of
time
§  No activist shareholders to push them to sell
§  Location – rural vs. metropolitan. Most of the larger, public banks have
pushed to expand in metro markets
§  More “weird” stuff
26

Valuation
Overview
Source: www.mercercapital.com
27
Valuation
Overview
Valuation Approaches
§  American Society of Appraisers (ASA) recognizes three general
approaches to valuation
§  Asset Approach
§  Income Approach
§  Market Approach
§  Within each approach, there are a variety of methods that appraisers use
to determine value
28

Valuation
Overview
Asset Approach
»  “… a general way of determining a value indication of a business, business ownership interest, security, or
intangible asset using one or more methods based on the value of the assets net of liabilities.”
»  Methods include: Net Asset Value
Income Approach
intangible asset by using one or more methods through which anticipated benefits are converted into
value.”
»  Methods include: Discounted Future Benefits
Market Approach
intangible asset by using one or more methods that compare the subject to similar businesses, business
ownership interest, securities, or intangible assets that have been sold.”
»  Methods include: Transactions, Guideline Public Company, and Guideline Transactions
Source: ASA Business Valuation Standards, Published in November 2009
29
Valuation
Overview
Common Valuation Methods Applied When Valuing Banks
§  Market Approach

§  Transactions Method
§  Guideline Public Company Method
§  Guideline Transactions Method
§  Income Approach

§  Discounted Future Benefits Method
30
30


Valuation
Guideline Public Company Method
§  Value equals product of following inputs

§  Financial Metric
§  Multiple
§  Both the financial metric and/or multiple may be subject to

adjustment
§  Typically consider multiples of earnings, forward earnings (i.e.,

budgeted), and tangible book value
31
31

Valuation
§  Start with universe of public banks

§  Segment further by screen for
§  Size
§  Geography
§  Difficult to find a good group for more rural banks
§  Profitability (ROA, ROE, etc.)
§  Loan composition

§  Growth (loans, EPS, etc.)
32
32


Valuation
§  What if there is still no good group of comparable companies?

§  Start with a group of banks that is at least somewhat comparable (say,
$300 - $500 million in assets and a ROE > 10%)
§  Select a multiple

§  Statistical approach (pick a multiple at the lower quartile instead of the
median)
§  Adjust the median/average multiple judgmentally
§  Guideline transactions (i.e., merger and acquisition activity) can also
sometimes serve as a reference point
33
33


Public Market Historical Trends
Price/Earnings and Price/Book Value Multiples
Banks with Assets of $500 Million - $5 Billion & Return on Tang. Equity Between 5% and 15%
20.0 3.00
18.0
16.0 2.40
Price/Tangible Book Value Multiple
14.0
Price/Earnings Multiple
12.0 1.80
10.0
8.0 1.20
6.0
4.0 0.60
2002-2012 Medians:
P/E: 14.28x 2.0
P/TBV: 1.41x
0.0 0.00
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Price / Earnings 13.4 16.8 18.3 16.6 17.7 14.3 13.5 14.3 13.5 11.6 12.0
Price / Tang. Book Value 1.53 2.03 2.17 1.86 1.86 1.41 1.40 1.27 1.21 1.05 1.14
Source: Mercer Capital Research, SNL Financial
34

Valuation
Return on Tangible Equity
> 10%
Price/Earnings
X Return On Tangible Equity 0 to 10%
= Price/Tangible Book Value
0 to -10%
< -10%
Source: Mercer Capital Research & SNL Financial - 0.50 1.00 1.50 2.00
Price / Tangible Book Value
Pricing as of February 15, 2013 (Financial info through Dec. 31, 2012)
35
Valuation
Asset Quality Total Assets
>9% > $10 BN

Non-Performing Assets / Loans + OREO
6 to 9% $5 to $10 BN
3 to 6% $1 to $5 BN
< 3% < $1BN
- 0.50 1.00 1.50 - 0.50 1.00 1.50 2.00

Source: Mercer Capital Research, SNL Financial, Pricing as of February 15, 2013 (Financial info through Dec. 31, 2012)
36

Guideline Transactions Analysis

§  Perhaps easier to apply to a small bank than a larger bank due to
fact that most transaction activity involves smaller banks
§  Can tailor the analysis relatively closely to the subject bank’s
location, size, performance, etc.
§  Trade-off is the timeliness of data.
§  Consider multiples of earnings, tangible book value, and core

deposits
37
37

Guideline Transaction Analysis

Non-Assisted Bank & Thrift Acquisitions 1990-2012
600 566 $300
550
504
500 481 $250
463 458 463
450
399
400 357 $200
Bank & Thrift Transactions
Deal Value ($B)
350 309 323

305 283
300 280 $150
261 272 278
232 233
250 217 216 215
200 177 175 $100
150
100 $50
50
0 $0
Bank & Thrift Transactions Deal Value

Source: Mercer Capital Research (“Outlook for Bank
M&A in 2013 Presentation”) & SNL Financial
38
38



M&A Multiples – P/E and Price/TBV
50x 300%
46x 275%
42x 250%
38x 225%
34x 200%
Price / Earnings
Price / TBV
30x 175%
26x 150%
22x 125%
18x 100%
14x NM 75%
10x 50%
Price / Earnings Price / TBV
Source: Mercer Capital Research (“Outlook for Bank

39
39


Price/TBV vs. ROTE
Bank and Thrift Transactions
2012 to 2/6/2013
30%
20%
10%
0%
ROAE
-10%
-20%
-30%
0.0x 0.5x 1.0x 1.5x 2.0x 2.5x 3.0x
Source: Mercer Capital Research (“Outlook for Bank Price/Tangible Book Value
40

Valuation
§  Relies upon a projection of future financial performance

§  Requires following inputs
§  Interim cash flows to shareholders/investors (dividends)
§  Amount necessary to be retained for the bank to achieve its target capital
structure (based on a target capital ratio)
§  A “terminal” or “residual” value
§  Represents value of all cash flows received after the end of the forecast period
§  Discount rate
§  Discounting convention
§  Value equals the sum of the present value of the cash flows (#1 and #2
above), discounted at the discount rate
41
41

Valuation
§  DCFs are helpful in certain circumstances:

§  Near-term growth is expected to exceed long-term
expectations
§  Near-term profitability is low/high and is expected to
revert to a mean
§  Capital structure may change in the future
42
42


Valuation
Special Issues
§  Possible ways to handle need for an adjustment:

§  When Estimating Financial Metric
§  Adjust the subject bank’s income statement and balance sheet
§  Estimate earning power via normalized ROA or ROE
§  When Estimating Multiple

§  Adjust multiple derived to account for risk and/or growth differentials
§  Carve out part of the business and value

separately
43
Valuation
Special Issues – Common Adjustments
Income Statement Balance Sheet

»  Eliminate non-recurring gains and »  Adjust for unrealistic valuation of
losses assets
»  Eliminate other income and expense §  Securities

items
§  Investments in other companies
»  Recognize normalized loan loss carried at cost or equity
provision (i.e., greater than net charge-
offs) »  Recognize estimated cost of settling
contingent liabilities
»  Normalize tax rate
»  Normalize loan loss reserve
»  Purchase accounting amortization
»  Adjust intangible assets
»  Life insurance proceeds
44

Valuation
Special Issues
§  S corporation banks

§  Bank itself records no corporate income taxes (taxes “pass
through” to and are paid by shareholders)
§  Tax effect earnings as if it were a C corporation, because multiples
are derived from public C corporations
§  Benefit of S election (avoidance of double taxation on shareholder

distributions can be captured in the marketability discount)
45
45

Valuation
Special Issues
Marketability Discount
§  Market Approach – Restricted stock studies, pre-IPO studies
§  Income Approach – Project cash flows over the expected

holding period of the investor. Discount cash flows to present at
a higher rate that reflects incremental risk of illiquidity
46
46


Valuation
Special Issues Trading Volume
> 2.0%
Weekly Trading Volume / Shares Outstanding

Weekly NPAs /
Trading Assets Loans+OREO ROTCE 1.0 to 2.0%
< 0.5% 733,895 4.01 5.83
0.5 to 1.0% 1,700,931 3.10 9.81
1.0 to 2.0% 2,823,692 3.07 9.82
> 2.0% 14,913,012 2.08 11.65
0.5 to 1.0%
< 0.5%
- 0.50 1.00 1.50 2.00

Source: SNL Financial, Pricing as of February 15, 2013 (Financial info through Dec. 31, 2012) Price / Tangible Book Value
47
Valuation
Special Issues
§  Weightings
§  Holding Company & Bank
§  Options
§  Unique Capital Structure
§  Trust Preferred, Preferred (TARP, SBLF, Other), Types of
Common (Voting/Non-Voting, Different Classes)
48
48


Web Resources
www.fdic.gov
§  Contains deposit market share data for all FDIC insured banks by geographic area
§  www.fdic.gov/sod/index.asp
§  Contains the FDIC Quarterly Banking Profile, which provides a comprehensive summary of financial results for all
FDIC-insured institutions and trends in banking industry
§  www.fdic.gov/qbp/index.asp
www.ffiec.gov
§  Provides access to regulatory filings (Call Reports, FR Y-9Cs, FR Y-9LP and FR Y-9SPs for FDIC-insured financial
institutions
§  www.ffiec.gov/reports.htm
§  Provides Uniform Bank Performance Report, a report detailing performance and composition data for subject
bank relative to peer group
§  www.ffiec.gov/UBPR.htm
www.snl.com
§  Subscription site
§  Provides data and industry news (comparable to Bloomberg but primarily dedicated to financial institutions)
49
Questions?
Jay D. Wilson, Jr., CFA, CBA
901.322.9725
wilsonj@mercercapital.com
Mercer Capital
5100 Poplar Avenue, Suite 2600
Memphis, TN 38137
901.685.2120
www.mercercapital.com
50

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Bank Valuation Basics!

Bank Valuation Basics

About Mercer Capital

© 2013 Mercer Capital // www.mercercapital.com! 1!

Outline for Today’s Presentation

Part One: Part Two:

Financial Statement Basics Guideline Public Company Method

Recent Industry Trends

Discounted Future Benefits Method

§ Financial institutions include several kinds of financial entities

§ Asset managers – RIAs, hedge fund managers, PE managers, broker/

§ Insurance companies – Agencies, Underwriters, Ancillary

§ Specialty Finance and Real Estate Companies

© 2013 Mercer Capital // www.mercercapital.com! 2!

§ Depository institutions have several common characteristics

§ Deposits are generally insured by the federal government

§ Chartered by federal government or various states and regulated by agencies of

§ Community banks are a subset of this group

§ Other interesting notes from FDIC study

© 2013 Mercer Capital // www.mercercapital.com! 3!

§ Banks vs. Operating Companies

§ Key Differences

Balance Sheet Overview Assets

Cash Long-term Debt

© 2013 Mercer Capital // www.mercercapital.com! 4!

Total Securities Interest Income

drives its income Total Earning Assets

statement, let’s Bank Premises

start with the Cash Surrender Value of Life Insurance

TOTAL ASSETS Fee Income

Non-Interest Operating Expense

Key Balance Sheet Items

§ Capital adequacy is key

© 2013 Mercer Capital // www.mercercapital.com! 5!

Net Interest Income Total Revenues

§ Return on Assets

© 2013 Mercer Capital // www.mercercapital.com! 6!

§ Key regulatory agencies include:

© 2013 Mercer Capital // www.mercercapital.com! 7!

§ Push to reduce parent company leverage

§ Reworking of asset risk weights creates potential issue

§ Loan demand weak in most regions

§ Operating leverage is tough to achieve given pressure on revenues

§ Regulatory expectations regarding higher capital ratios (and more

© 2013 Mercer Capital // www.mercercapital.com! 8!

Net Interest Margin

More pressure to come

Peer group consists of approximately 3,600 banks with assets

Source: Mercer Capital Presentation at AOBA Conference “Capital

(Net Int’t Income + 2005 2009 2012

Non-Int’t Income) Source: Bank Holding Company Performance Reports

Source: Mercer Capital Presentation at AOBA Conference “Capital

© 2013 Mercer Capital // www.mercercapital.com! 9!

Loan Loss Provision +/- OREO Losses/Gains / PTPPPO Income

PPOI 1.20% 30.00%

But … credit leverage 0.80% 20.00%

is limited going 0.60% 15.00%

forward 0.40% 10.00%

70s & 80s saw ROE 12%!

recessions and 6%!

90-06 “great -4%!

Assets > $10B! Assets $1-10B!

Source: Mercer Capital Presentation at AOBA Conference “Capital

§  Financial institutions include several kinds of financial entities

§  Asset managers – RIAs, hedge fund managers, PE managers, broker/

§  Insurance companies – Agencies, Underwriters, Ancillary

§  Specialty Finance and Real Estate Companies

§  Depository institutions have several common characteristics

§  Deposits are generally insured by the federal government

§  Chartered by federal government or various states and regulated by agencies of

§  Community banks are a subset of this group

§  Other interesting notes from FDIC study

§  Banks vs. Operating Companies

§  Key Differences

§  Capital adequacy is key

§  Return on Assets

§  Key regulatory agencies include:

§  Push to reduce parent company leverage

§  Reworking of asset risk weights creates potential issue

§  Loan demand weak in most regions

§  Operating leverage is tough to achieve given pressure on revenues

§  Regulatory expectations regarding higher capital ratios (and more

§  Valuation is a range concept

§  Impact of assuming an inappropriate level of risk is usually not

§  Composition of loan portfolio – greater dependence on particular type of lending

§  Capital structures – not as leveraged. Regulatory capital requirements filled to a

§  Diversification – not as diversified, as measured by geography, customer, etc.

§  Income Approach

§  Market Approach

§  Market Approach

§  Guideline Public Company Method

§  Guideline Transactions Method

§  Income Approach

§  Value equals product of following inputs

§  Both the financial metric and/or multiple may be subject to

§  Typically consider multiples of earnings, forward earnings (i.e.,

§  Start with universe of public banks

§  Profitability (ROA, ROE, etc.)

§  Loan composition

§  What if there is still no good group of comparable companies?

§  Select a multiple

§  Consider multiples of earnings, tangible book value, and core

§  Relies upon a projection of future financial performance

§  DCFs are helpful in certain circumstances:

§  Possible ways to handle need for an adjustment:

§  Estimate earning power via normalized ROA or ROE

§  When Estimating Multiple

§  Carve out part of the business and value

»  Eliminate other income and expense §  Securities

§  S corporation banks

§  Benefit of S election (avoidance of double taxation on shareholder

§  Market Approach – Restricted stock studies, pre-IPO studies

§  Income Approach – Project cash flows over the expected